Margin Calls, Redemptions Weigh on Market

Margin Calls, Redemptions Weigh on Market - Shu-Ya Peng...

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Shu-Ya Peng Margin Calls, Redemptions Weigh on Market Article Summary The October stock market rout was happen partially due to force selling by the margin cals. The broker and exchange has collateral requirements that require investors to maintaining a fixed level of cash as collateral when trading on margin. The force selling can trigger a vicious circle that creates more selling. The level of collateral required is based on potential losses in stress test that use historical volatility as references. After the collapse of the Lehman Brothers, the volatility busts out the historical range and brokers have to change assumption to increase the amount of collateral needed. Increased of the collateral requirements would trigger margin adjustments and waves of margin calls and force selling. Analysis: When investors buy securities, they can use brokers’ call loans to leverage. Part of the purchase price is from the broker and part is from the investor. The broker then borrows money from banks at the call money rate to finance the brokers’ call. As we can see here, margin will increase
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